Earlier this year, the world economy had a lucky escape. After a mild winter in Europe, energy prices were in retreat as the continent shifted away from Russian gas supplies. Inflation was cooling, while economic growth remained resilient.
“Hello lower gas prices, bye-bye recession,” analysts at the US investment bank JP Morgan wrote in January. Less than a year later, the Israel-Hamas war serves as a stark warning that the global energy crisis has far from vanished.
European gas prices have jumped by more than a third since the start of October, before a difficult winter to come, as the conflict in the Middle East threatens to escalate. Oil prices have risen sharply, with a leap of more than $20 a barrel since June, continuing a rise that began even before the war.
While not underestimating the human tragedy in Israel and Gaza, most experts reckon that a serious escalation engulfing the wider region remains unlikely – limiting the impact for the world economy. Yet the outbreak of war in another of the world’s most important energy exporting regions, less than two years after the Russian invasion of Ukraine, is an all too painful reminder of economic vulnerabilities.
Mohamed El-Erian, the president of Queens’ College, Cambridge, and a former deputy managing director of the International Monetary Fund, says a further rise in tensions would compound existing fragilities as policymakers navigate weak economic growth and stubborn inflation.
“If this horrific crisis is not contained then this will add to the supply constraints facing the global economy. The very first impact will be higher prices, and possibly less oil around, and that is inherently stagflationary. It’s not just inflationary, it’s stagflationary,” he says.
At a highly uncertain juncture, the extreme risk is the possibility of Iran becoming directly involved and impeding transit through the Strait of Hormuz – the supply route for about 30% of the world’s seaborne oil and one-fifth of global liquified natural gas (LNG). It’s a concern raised with alarming regularity – in these darkest of days for the Middle East, this is a danger many are considering.
For Britain and other European countries there should be particular alarm. After efforts to diversify gas supplies away from Russia, the reliance on fossil fuel imports from the Middle East has only risen – especially from Qatar, the world’s largest LNG exporter, which ships through Hormuz.
European LNG imports from the gulf state rose by 71% last year in the rush to replace Russian gas – including a 74% rise to the UK, which sources almost one-third of its imported supply from the country.
With the UK experiencing a much slower decline in inflation than almost any other advanced economy, there is potential for any renewed energy shock to trigger a fresh phase in the cost of living crisis before the last one is over.
Fossil fuels account for almost 80% of the UK’s primary energy consumption, and reliance on imports is a risk the government is all too aware of. So far, Rishi Sunak’s answer to the question of Britain’s energy security has been to redouble efforts to exploit North Sea oil and gas reserves.
The prime minister also wants to see billions of pounds invested in renewables, carbon capture and storage, and nuclear. Yet despite promising “long-term decisions for a brighter future” in his Tory party conference speech, nowhere near enough is being done to move to a low-carbon economy fit for an increasingly volatile world.
Rather than accelerate the transition, Sunak has chosen to water down net zero policies in an attempt to build a narrow electoral advantage. This is not only shortsighted, but makes little economic sense.
After the Covid pandemic, leading nations have struggled to cope with successive shocks to the supply side of the economy – not least because of the current energy crisis. All have added to inflationary pressures, fuelling the cost of living emergency.
One shock is the restructuring of global supply chains. After severe disruption in the pandemic, and in an increasingly volatile geopolitical world, businesses are putting more emphasis on resilience over efficiency. Supply chains are being reshored, nearshored and friendshored, with higher costs entailed.
Another disruption is the function of the labour market. Repatriation of workers during the pandemic, and tighter post-Brexit controls on migration in the UK, alongside an ageing population, have cut the supply of workers available to businesses.
However, the energy crisis also presents a serious economic opportunity – from the jobs, growth and future energy security that building a low-carbon economy could bring.
In the US, Joe Biden is aiming to capture this opportunity with the vast Inflation Reduction Act, ploughing billions of dollars into helping the US meet its climate goals, while creating jobs and ultimately bringing down bills for households and businesses.
It’s a plan that EU nations are responding to, and one now forming the cornerstone of Labour’s economic agenda. As free marketeers, the Conservatives are naturally sceptical, yet there is a recognition in the mainstream of economics that state activism and taxpayer funding are vital components in this transition.
“This is a case where governments need to be involved in partnership with the private sector,” says El-Erian. “These are generation-defining transitions the private sector can’t handle on its own.”
Britain has a serious opportunity to revive growth and restore economic security. Given the clear risks in the world economy, there isn’t a moment to lose.
